Mark Abell 1
As will become apparent from the chapters of this book, franchising is regulated in some countries by specific franchise laws. These can be categorised as competition law regulations, foreign trade or investment regulations and core franchise regulations. Competition law regulations seek to prevent the restriction of trade. They are concerned with issues such as the tying in of peripheral or unconnected goods, price maintenance, exclusivity and so on. The EU (in the form of Article 101 of the Treaty on the Functioning of the European Union and the Vertical Restraints Block Exemption), Japan2 and Venezuela3 are examples of countries that regulate franchising in this manner.
Developing markets such as China, Indonesia, Kazakhstan, Korea, Moldova, Russia, Ukraine, Belarus, Barbados and Vietnam use foreign trade and investment regulations to protect their economies and often have political and social aims, such as the creation and distribution of wealth. Core franchise regulations are concerned with the way that franchises are sold, particularly the creation of what might be called pre-contractual hygiene. They do this by a variety of means, including mandating pre-contractual disclosure and the terms of the in-term relationship between the franchisor and its franchisees. More developed franchise markets such as the United States, Australia, Canada, Brazil, Taiwan, Mexico, France, Spain, Italy, Belgium and Sweden tend to take this approach. Some countries have adopted a hybrid approach to the regulation of franchising. For example, the South African Consumer Protection Act 2009 is a cross between competition law regulations and core franchise regulations, while both Malaysia and China have a mixture of foreign trade and investment franchise laws and core franchise regulations. Some countries, such as Croatia, define franchise agreements but do not regulate them.4
In addition to the 30 countries that have franchise-specific laws, Tajikistan5 is also currently contemplating enacting one. The New Zealand government has recently rejected the need for a franchise-specific law.6 The majority of these franchise regulations can be best categorised as foreign trade and investment regulations. They are more concerned with regulating foreign investment and trade than ensuring the potential franchise abuses are prevented or at least reduced.
I THE DEFINITION OF FRANCHISING
The search for clarity in legislative definitions of franchising is unfortunately not particularly helped by the United States. The definition of ‘franchising’ used by the Federal Trade Commission for more than 20 years is widely used, although in the 15 states that have their own franchise disclosure and registration laws and the more than 20 states and territories that have their own relationship laws (some states have both, sometimes in the same statute), there is no single definition of the term ‘franchising’.
Nevertheless, the two basic approaches taken by the US legislators when attempting to define franchising have had a significant impact upon many of those jurisdictions that have adopted franchise-specific regulations.
The ‘prescribed marketing plan or system approach’7 to defining a franchise is most prevalent in the US states. Other states take a broader approach and refer to a ‘community of interest’ in the marketing of goods or services.8 Even within these two general categories, there are noteworthy differences.
The prescribed marketing plan or system approach raises the issues of ‘control and assistance’, and the use of the franchisor’s brand. These are dealt with in differing ways by the various statutes and the Federal Trade Commission.
The state of California’s franchise legislation was the United States’ first franchise law when it was introduced in 1970.9 It adopts the ‘prescribed marketing plan or system approach’ and defines a ‘franchise’ as a contract or agreement, either express or implied, whether oral or written, between two or more persons by which:
- a a franchisee is granted the right to engage in the business of offering, selling or distributing goods or services under a marketing plan or system prescribed in substantial part by a franchisor;
- b the operation of the franchisee’s business pursuant to such a plan or system is substantially associated with the franchisor’s trademark, service mark, trade name, logo type, advertising or other commercial symbol designating the franchisor or its affiliate; and
- c the franchisee is required to pay, directly or indirectly, a franchisee fee.
The definition has been extended to include petroleum dealers. There are also definitions of franchisor, franchisee and franchise fee. This fairly general definition is typical of those to be found in many other US state franchise laws.
The Amended Federal Trade Commission Franchise Rule requires the franchisor to exert control over the franchisee’s method of operation or to provide significant assistance in the franchisee’s method of operation.
The FTC definition is a broad one and, when originally enacted, its first part related to business format franchises10 and the second part extended it to business opportunities such as vending machine businesses.11 Certain specific types of relationship are expressly excluded.12 When the FTC Franchise Rule was amended in 2007, the business opportunity rule was spun off into a separate regulation.13
In any event, under the Amended FTC Rule, the franchisee must operate under the franchisor’s brand – either by selling goods, commodities or services bearing the brand or operating under the brand and selling goods, commodities or services meeting the franchisor’s quality standards.
There is little substantive difference between the FTC Rule and the various state approaches.
- a the franchisee is granted the right to engage in the business of offering or distributing goods or services using the franchisor’s trade name or marks;
- b the franchisor and franchisee share a community of interest in the marketing of the goods or services; and
- c the franchisee pays a franchise fee.
‘Community of interest’ generally means a continuing financial interest between the parties in the operation of the franchisee’s business or the resale of the franchisor’s products. Since most commercial relationships involve some type of continuing financial interest, this definition is potentially broader in application than most ‘marketing plan’ definitions.
Community of interest is defined by the Wisconsin statute as a ‘continuing financial interest between the grantor and the grantee in either the operation of the dealership business or the marketing of such goods or services’.16 Since most dealership and franchise relationships involve some type of continuing financial interest, the ‘community of interest’ definition of a franchise has a potentially wider application than the prevailing ‘marketing plan’ definition.
Most of the cases addressing whether a community of interest exists have arisen under the Wisconsin or the New Jersey statute. The 1987 Ziegler decision by the Wisconsin Supreme Court17 lists factors that should be considered in determining whether a community of interest exists under the dealership law.18
In determining whether a community of interest exists for purposes of the New Jersey statute, courts have focused on the extent of the alleged franchisor’s control over the alleged franchisee, the franchisee’s economic dependence on the franchisor, the relative bargaining power of the parties, and the presence of franchise-specific investments by the franchisee. A primary factor in this equation is interdependence, which generally arises when the franchisee invests heavily in the franchise business such that its economic health hinges on the continuation of that business.
Interdependence has been found where a distributor was contractually obliged to develop demand for a supplier’s products, was barred from developing or selling competing products,19 performed joint sales and marketing activities with the supplier, and derived 97 per cent of its revenue from sales of the supplier’s products. The percentage of revenues or sales attributable to the franchisor’s products is not dispositive of the interdependence issue, but franchisees and dealers whose revenues attributable to a supplier’s products are relatively small generally have a hard time establishing interdependence and a community of interest.
As evidenced by the following sections, the definitions of franchising adopted in other jurisdictions can be categorised as taking either a ‘prescribed marketing plan or system’ or a ‘community of interest’ approach.
II INFLUENCE OF THE PRESCRIBED MARKETING PLAN OR SYSTEM APPROACH ON OTHER JURISDICTIONS
The key characteristic of the prescribed marketing plan or system definition is that the business must be ‘substantially associated’ with the franchisor’s trademark, trade name, or other commercial symbols to qualify as a franchise. There is often an element of control to be exercised by the franchisor as well.
A classic example of this is the definition used by the state of Alberta in Canada, which, not surprisingly given its proximity to the United States, focuses on the marketing plan. Its definition of franchising includes a ‘marketing or business plan prescribed by the franchisor’, a ‘substantial association with trademarks’ and ‘significant operation control’ by the franchisor.20
Australia also takes a very comprehensive approach. Clause 5(1) of the Competition and Consumer (Industry Codes – Franchising) Regulation 2014 (New Code) defines a franchise agreement as an agreement:
(a) that takes the form, in whole or part, of any of the following:
(i) a written agreement;
(ii) an oral agreement;
(iii) an implied agreement; and
(b) in which a person (the franchisor) grants to another person (the franchisee) the right to carry on the business of offering, supplying or distributing goods or services in Australia under a system or marketing plan substantially determined, controlled or suggested by the franchisor or an associate of the franchisor; and
(c) under which the operation of the business will be substantially or materially associated with a trade mark, advertising or a commercial symbol:
(i) owned, used or licensed by the franchisor or an associate of the franchisor; or
(ii) specified by the franchisor or an associate of the franchisor; and
(d) under which, before starting or continuing the business, the franchisee must pay or agree to pay to the franchisor or an associate of the franchisor an amount including, for example:
(i) an initial capital investment fee; or
(ii) a payment for goods or services; or
(iii) a fee based on a percentage of gross or net income whether or not called a royalty or
franchise service fee; or
(iv) a training fee or training school fee;
(v) payment for goods and services supplied on a genuine wholesale basis; or
(vi) repayment by the franchisee of a loan from the franchisor or an associate of the
(vii) payment for goods taken on consignment and supplied on a genuine wholesale basis; or
(viii) payment of market value for purchase or lease of real property, fixtures, equipment or
supplies needed to start business or to continue business under the franchise agreement.
The definition then goes on the state that a transfer, renewal or extension of a franchise agreement and motor vehicle dealerships21 are included within the definition. A list of other relationships, such as employer–employee, landlord and tenant and cooperatives are excluded from the definition.22
Certain limited types of franchise agreements are also exempted from the Code.23
This definition is one of the most comprehensive and can be interpreted to cover a broad range of arrangements. Although the term ‘franchise’ is normally used to describe business format franchising, the definition in the Australian Code has the potential to capture a wide range of licensing, distribution and agency arrangements not traditionally considered to be a franchise arrangement. Having an express list of non-qualifying arrangements is also an effective way of excluding non-franchise relationships.
The Australian definition succeeds in being comprehensive, but sacrifices succinctness.
Although Australia and Alberta require ‘substantial association’ with marks, Indonesian franchise law shows interchangeability between the brand and other intellectual property. It defines franchising as ‘an agreement in which one party is given the right to utilise and/or use the right over the intellectual property or invention or unique business characteristics owned by another party against a fee’.24 This interchangeability is unique and sets the Indonesian definition apart from most others.
Certain jurisdictions stipulate that the franchisor should assist the franchisee in running the business. In Korea the franchisor is required to ‘support, educate and control’ the franchisee in the ways of its business.25 In Malaysia the definition of franchising includes a responsibility on the franchisor to ‘provide assistance to the franchisee to operate his business, including help with the provision or supply of materials, services, training, marketing, business or technology’.26 This is an interesting addition to a market plan definition and acknowledges the fact that most franchisees will need assistance to start up the business. Interestingly, the more detailed definition used in Australia is not as comprehensive in this area.
Most of the definitions mentioned above include the payment of a fee. Mexican law, however, is interesting in that it does not.27 This potentially broadens the impact of the law to include relationships that are between not-for-profit organisations or that are peer networks. Although this extension may be valuable in catching some additional arrangements, the vast majority of franchisees will be paying some sort of fee.
The influence of the prescribed system approach is not restricted to franchise-specific laws. It can be found in case law and non-governmental organisations.
For example, neither the Hungarian Civil Code nor any other piece of legislation in Hungary defines franchising. Instead, definitions have been developed by the courts. One judgment suggests that the main feature of a franchise is, that ‘a company (franchisor) transfers the exclusive right of selling goods and services to retail units which were introduced by him onto the market under a trade mark’.28
A more thorough definition is offered in another judgment. It defines a franchise as an atypical, unregulated contract whose main characteristics are that: ‘the franchisor has an obligation of transferring a complex system to the franchisee, a system which has been worked out diligently from a professional and trading point of view and has already been effectively tested under market circumstances with the right of usage of a trade name and complete training’.29
It is noteworthy that both of the definitions offered take a prescribed system approach and refer to the marks’ trade name.
The International Institute for the Unification of Private Law has drafted a definition that falls into the ‘prescribed system’ category with the intention of it being compatible with most private law systems.30
The use of the word ‘prescribes’ and the phrase ‘substantially associated’ follows the approach seen in the United States, Australia and Alberta. Interestingly there is an element of ‘assistance’, as seen in the Korean definition, and master franchise agreements are expressly included (as they are in Alberta) to avoid any doubt, so avoiding the risk found in Lithuania that master franchises are not within the definition.
This definition is fairly succinct and accurately describes the franchise relationship. It focuses upon the form of remuneration paid by the franchisee to the franchisor so as to distinguish it from selective distribution channels. However, it seems to simply rearrange definitions that are already in existence and offers nothing groundbreaking that captures the imagination. Interestingly, it has not been adopted by any of the legislators that have sought to define franchising.
No countries have adopted a ‘pure’ community of interest approach, probably because the definitions based on it are broader and lack the detail or accuracy of some of the lengthier marketing plan definitions.
However, many definitions contain certain elements of it mixed in with those of a prescribed system approach.
Italy has a definition of franchising that covers intellectual property (IP) rights, commercial assistance and fees very concisely.31 It does not deal with control by the franchisor. It merely describes the business aspect as a ‘franchising network’ and is therefore not detailed enough to give an accurate description of what a franchise entails. The Romanian version is equally succinct and requires the parties to ‘continually cooperate’ and be ‘financially independent’ from each other.32 It requires the parties to be named as franchisor and franchisee, however, and is silent on intellectual property rights, which is far from ideal.
Spanish law33 offers a very broad definition that relates entirely to the rights granted by the franchisor and apparently the use of the words ‘franchisor’ and ‘franchisee’. It defines a franchise as an activity that ‘is carried out by virtue of an agreement or contract by which a company, known as the franchisor, grants to another, known as a franchisee, the rights to exploit its own system of commercialisation of products or services’. Although this can still be classified as a marketing plan or prescribed system approach, it is so broad that it is almost meaningless. Describing the business as a ‘system of commercialisation products or services’ does not adequately describe the IP rights exploited by the franchisee and there is no mention of a fee. Furthermore, if a strict interpretation is used, the definition will not catch any arrangement where the terms ‘franchisor’ or ‘franchisee’ are not used by the parties.
The Lithuanian definition of franchising34 still has its roots in the Russian Civil Code defining the agreement as a contract between the ‘right holder’ and a ‘user’ rather than franchisor and franchisee. Reflecting both the country’s socialist past and again the Russian pedigree of the Code, it expressly states that the parties to a franchise agreement must be either legal entities or entrepreneurs.35 Presumably this is to avoid a government agency being involved in a franchise.
The definition covers the basic elements of a franchise contract, remuneration and the use of intellectual property rights or trademarks, but limits the latter two to exclusive rights only.36 This ignores the possible existence of master franchise agreements under which the master franchisee does not enjoy exclusive rights and is therefore somewhat rudimentary.
The Brazilian franchise law defines a franchise as:
[A] system whereby a franchisor licenses to the franchisee the right to use a trademark or patent, along with the right to distribute products or services on an exclusive or semi-exclusive basis and, possibly, also the right to use technology related to the establishment and management of a business or operating system developed or used by the franchisor, in. exchange for direct or indirect compensation, without, however, being characterised as an employment relationship.37
While this has something in common with the community of interest approach, the interchangeability of the brand and a patent is an interesting and unique concept that differentiates it from most other definitions, but draws some comparisons with the interchangeability in the Indonesian system. There are also elements of the prescribed plan approach, as the franchisor’s ‘operating system’ must be used.
Taiwan’s ‘Standards Governing Disclosure of Information by Franchisors’38 seem to confuse the marketing plan or prescribed system and the community of interest approach and define a ‘franchise operating relationship’ in terms of a community of interest as ‘a continuing relationship in which an enterprise, through contractual means, licenses its trademarks or operating know-how for use by another enterprise and assists or offers guidance to that other enterprise in its operations, and for which the other enterprise provides specific consideration’.39 This shows the kind of relationship required for a community of interest approach but also the assistance and guidance seen in the marketing plan approach.
III THE NEED FOR FRANCHISES TO HAVE BEEN PILOTED
There is sometimes a concern that until a franchise model has been tested in a new market it is not fit to be franchised to third parties. As a result, some countries such as China and Vietnam prohibit franchising until the concept has been piloted in the local market. In China there is a requirement that the franchisor establish and operate two company-owned units for more than one year before granting franchises to third parties.40 Although the original regulation required that this pilot had to be in China, this requirement has been modified mirroring the debate in Italy, so that the pilot can be anywhere.
Article 2 of the Vietnamese Commercial Law of 2001 requires that franchisors must hold a Vietnamese business licence41 and that the franchise system has been in operation for at least a year before a franchise can be granted. The Vietnamese master franchisee of a foreign brand is required to have operated the franchise business for 12 months or more prior to granting sub-franchises to unit franchisees.42
Pre-contractual disclosure is the most common form of franchise-specific regulation and all those countries that require this are heavily influenced by the US Uniform Disclosure Document (US UFDD).
i Timing of disclosure
Pre-contractual disclosure must usually be given between 10 and 21 days prior to the execution of the franchise agreement. Malaysia, Taiwan and Brazil require disclosure at least 10 days prior to the execution of a franchise agreement. Korea requires only five days, while the Canadian states all require 14 days, Mexico 30 days, China 20 days and Vietnam 15 days.
ii Cooling-off period
A number of countries such as Malaysia, Mexico and Taiwan require a cooling-off period during which the franchisee can withdraw from the relationship without penalty. These range from a 30-day cooling-off period in Mexico43 to five days in Taiwan.44
Following the lead of the US UFDD, most countries that require pre-contractual disclosure require the same sort of information to be disclosed to the potential franchisees, although the details tend to vary. The information generally required to be disclosed is discussed below.
Basic details of the franchisor
Every country with franchise-specific disclosure legislation requires the franchisor to give some basic details about its business. The amount of detail that has to be disclosed varies from rudimentary information about the franchisor (like in Indonesia or Japan), to more detailed information about the franchisor’s business experience, its history of development and information about the business experience of the main people involved on the franchisor’s side such as its directors and manager. Not surprisingly the countries with pure franchise regulations such as Canada and Malaysia require a franchisor to provide more franchise-specific information than others.
Description of the franchise and of the market
Almost all disclosure countries require the franchisor to give a short description of the franchise in question. In addition, some countries such as France, Brazil and Vietnam also require the franchisor to provide details of the territory or the market where the franchise is supposed to operate.
Financial information about the franchisor
Although the requirements regarding this item do not seem to be as strict as those set out in the US UFDD in that the bankruptcy history of the franchisor and its affiliates usually does not have to be disclosed (with the exception of Brazil, Canada, China and Malaysia), most disclosure countries require the franchisor to provide the prospective franchisee with balance sheets and financial statements for the past two years with the exception of Japan, Mexico and Taiwan.
Details of the franchise network
Most disclosure countries require the franchisor to give details about the franchise network, including providing the prospective franchisee with names and addresses of existing franchisees and information about franchisees who left the franchise network. The period that needs to be covered varies from 12 months before the franchise agreement is signed (in Brazil) to three years in the case of Canada.
Details concerning litigation that has to be provided can be divided into franchise-related litigation and general civil or criminal litigation regarding the franchisor and its directors or managers involved in the sale of the franchise. Some disclosure countries follow this distinction and refer to two separate items (e.g., Canada or China); others simply refer to details about litigation in general, depending how detailed the disclosure laws are.
Initial fee, initial investment and continuing fees
Most disclosure laws list the disclosure of fees and other payments that have to be made in accordance with the agreement as separate disclosure items (with the exception of Indonesia). Nevertheless, all disclosure countries require the franchisor to disclose the amount of initial fees and ongoing fees that are payable to the franchisor. Japan and Taiwan also explicitly require the franchisor to specify under which circumstances the initial fee is repayable to the franchisee. When it comes to giving details about the initial investment the franchisee will have to make, not all countries require the franchisor to do so. Unlike under the US UFDD, no country requires the franchisor to disclose during which period the franchisee’s initial investment will be amortised, not even Canada (where it is optional to do so), which most resembles the US franchise-specific legislation. The disclosure laws of Indonesia, Japan and Taiwan do not even require the disclosure of the initial investment.
With the exception of the United States, Canadian and Japanese franchise legislation, no other disclosure legislation mentions earning claims. In Canada and Japan it is optional for the franchisor to make such claims in the disclosure document. The only condition is that if earning claims are made, they have to have a reasonable basis. Franchisors in Canada are also required to include the material assumptions underlying the preparation and presentation of the earnings claim and they have to indicate the place where the prospective franchisee would be able to inspect substantiating documents.
Restrictions on the franchisee
Restrictions on the franchisee during the ongoing relationship consist of restrictions on the goods or services that can be provided by the franchisee, non-competition covenants and restrictions on the sale of the franchisee’s business. The general rule is that restrictions on the franchisee’s economic freedom of action have to be disclosed in every country. Similar to the litigation item, some countries with more sophisticated disclosure laws list the restrictive covenants that have to be disclosed separately (e.g., Canada or Malaysia); other simply refer to ‘the general obligations of the franchisee’ (e.g., Indonesia) or ‘conditions or limitations on the franchisee’s business’ (e.g., Korea).
Descriptions of the obligations that the parties owe towards one another
Although there is a primary focus on information that has to be provided about the obligations of the franchisee, the obligations of the franchisor, in particular with regard to training and assistance during the pre-opening, but also regarding continuing support during the ongoing franchise relationship, have to be disclosed to prospective franchisees.
Purchase ties and personal involvement of franchisee
If the franchisee is required to purchase certain goods from the franchisor, then this generally has to be disclosed, even though it might not be specifically mentioned in the disclosure law, but would fall under the broad heading ‘obligations of the franchisee’. The Canadian franchise legislation even goes a step further in that a franchisor not only has to disclose whether the franchisee has to purchase certain goods exclusively from it, but also any rebates from its suppliers on products that are sold on to the franchisee this way. In addition, any details about the franchisee’s personal involvement have to be given, if required under the franchise agreement (as in Brazil, Canada, Malaysia and Vietnam, where this is a separate disclosure item).
Term, termination, renewal
Surprisingly, two disclosure countries do not require a franchisor to make specific disclosure about the term of the agreement, its termination provisions and a possible renewal (Brazil and China). But it is important to note that some of the countries that do not require this separate information to be given require the franchisor to furnish the franchisee with a copy of the franchise agreement.
Details about franchisor’s IP rights
Only the following countries deal specifically with the disclosure of IP-related items: Brazil, China, Indonesia, Malaysia, Mexico, Taiwan and Venezuela.
Details of financing arrangements offered by the franchisor
Japan, Malaysia, Canada and Indonesia require the franchisor to disclose details about any financial arrangement offered to the prospective franchisee. In addition, a franchisor is also required in Japan to disclose whether it is prepared to provide financial assistance to a franchisee that finds itself in a difficult financial position.
Most disclosure countries require the franchisor to specifically disclose whether the franchise granted is exclusive or non-exclusive and whether the franchisor retains the right to operate corporate units in the territory granted (like in Japan).
Country-specific disclosure items
There are a number of countries that require disclosure of specific items that are unusual and shall therefore be mentioned in this section.
In Brazil, franchisors have to give a profile of the ‘ideal’ franchisee in the disclosure document, in particular with details of its business experience and educational background.
Under the Mexican franchise law, the franchisor has to provide detailed information about the method of calculation for determining profit margins and franchise commissions. This is a very burdensome requirement for franchisors.
In Taiwan, the franchisor has to give information about its management programme in the franchisee’s areas of operation.
iv Consequences of non-compliance
Failure to comply with the disclosure regulations generally results in the franchisee being able to reject the agreement so long as it does so within a reasonable time of entering into the agreement. Fines are also imposed in some jurisdictions.
In Canada, in the provinces of Alberta, Ontario, Prince Edward Island and New Brunswick, a prospective franchisee is able to rescind the franchise agreement on notice either 60 days after receiving the disclosure document or no later than two years after the franchise is granted, whichever is earlier.45 A right to damages also arises if the franchisee suffers a loss because of misrepresentation in the disclosure document.
In Brazil, failure to comply with the disclosure requirements entitles the franchisee to request the annulment of the agreement and require the reimbursement of all sums that may have already been paid to the franchisor or to any third party designated by the franchisor as franchise fees or royalties, monetarily corrected by the index of variation applicable to savings deposits, plus damages and losses.46
Reflecting the central government control of commercial laws, in China, if the franchisor fails to disclose material information or makes a misrepresentation, in addition to the franchisee being entitled to terminate the contract, the government can also impose fines. These range from 10,000 to 100,000 yuan. In addition, a public announcement of the violation will be made if it is a serious one.47
Jurisdictions with antitrust regulations take a slightly different approach to failure to properly disclose. In Japan, for example, failure to provide necessary disclosure amounts to the unfair trade practice of deceptive customer inducement and can result in the Japanese Fair Trade Commission issuing a cease-and-desist order or the franchisee obtaining an injunction in the courts.48
In Malaysia, violations of the disclosure law are punishable by the imposition of a fine. The court can also declare a franchise void, order refunds of all payments from the franchisee, and prohibit the franchisor from entering into new agreements.49
In Mexico, failure to comply with the disclosure requirements will subject a franchisor to a variety of administrative penalties, including fines, temporary closure of the business for up to 90 days, and administrative arrest for up to 36 hours.50
In Vietnam, Section 4 of the Decree provides for penal administrative provisions for, inter alia, non-compliance with the disclosure requirements.51
V MINIMUM TERM
It is unusual for a minimum term to be mandated for the franchise agreement. Nevertheless, in Malaysia the franchise agreement must be for a minimum period of five years.52 While in Indonesia, master franchise agreements must be for at least 10 years.53
VI A GENERAL DUTY OF GOOD FAITH
The imposition of a duty of good faith on the franchise relationship is currently being hotly debated in a number of jurisdictions, such as Australia, the United Kingdom and the United States. Some countries such as the Canadian provinces, China, Korea and Malaysia already impose a duty of good faith on both the franchisor and the franchisee.
Although it does not have franchise-specific laws, Germany imposes a heavy duty of good faith on franchisors, including, but not restricted to, the pre-contractual obligation to make proactive and full disclosure (culpa in contrahendo).
VII THIRD PARTIES
In Malaysia, Korea and Kazakhstan the role of third parties in franchising is regulated.
Malaysia governs the activities of franchise brokers.54 These are defined as persons ‘doing business as an agent or representative of a franchisor to sell a franchise to any person for a certain consideration but does not include any director, officer or employee of the franchisor or franchisee’.55
In Kazakhstan, licence brokers, which are defined as those ‘engaged in mediation activities in the course of concluding and performance of the complex business licence contract’,56 are regulated by the law, which states that they ‘may act both on their own behalf and at their own risk, and on behalf and at the risk of the licensor, licensee or other subjects of franchising relations in consideration for a licence broker’s fee, which can be payable in the form of a fixed single or periodic payment, fixed payments or otherwise, as provided by the contract’.57
In Korea, the law provides for the registration at the Fair Trade Commission of Franchise Consultants,58 who are involved in:
- a matters related to the business prospects of the franchise;
- b matters related to the preparation and revision of a franchise agreement and the information disclosure document;
- c matters related to the obligations of the franchisee and the conditions to the business operations of a franchise, etc.; and
- d matters related to the provision of education and guidance to the franchisee.
VIII DISCLOSURE BY POTENTIAL FRANCHISEES
Interestingly, in Vietnam, not only does the franchisor have to disclose information to the franchisee, but so does the franchisee to the franchisor. Article 9 of the Vietnamese Commercial Law states that, if the franchisor reasonably requests the franchisee to make full disclosure to it, the franchisee is under an obligation to do so.
IX REGISTRATION REQUIREMENTS
Some jurisdictions require the franchisor to register relevant details and documentation with a government agency. In developing markets this seems to be to enable the government to monitor franchisors doing business in the market, while in more developed economies (such as the United States and Spain) it is to ensure transparency and maintain a certain level of quality. Franchisors who sell franchises in China need to file relevant information with the competent commercial authority. If a franchisor wants to sell franchises in just one province, the information has to be filed at the local office of the MOFCOM of that province. For cross-province franchising, the application has to be filed with MOFCOM itself.
An application has to be made within 15 days of the execution of the franchise agreement and has to contain the following:61
- a basic information about the franchise system;
- b information about all the franchisees within China;
- c the market plan of the franchisor;
- d a copy of the business licence or any other qualification certificate of the franchisor;
- e a copy of the registration certificate for the registered trademark, patent and other operational resources concerning the franchising activities;
- f a document issued by the commercial authority at city level certifying that the franchisor owns at least two directly operated outlets that have been in operation for more than one year. For the directly operated outlets located outside China, the notarised and authenticated certificate of incorporation must be provided by the franchisor;
- g a sample franchise contract;
- h the index of the franchising operation manual;
- i if the products or services that are franchised are subject to the approval of relevant authorities, the relevant approval documents shall be provided by the franchisor;
- j a statement for the authenticity and the veracity of the filed information affixed with the signature of the franchisor’s legal representative and the franchisor’s corporate seal; and
- k information regarding the execution, rescission, renewal and modification of franchise contracts within the proceeding year. This information has to be updated by 31 March every year.
In Moldova, the franchise agreement must be registered with the State Agency for the Protection of Industrial Property,62 which must be informed when the agreement has ended.63 The Law does not provide for any consequences in the event the parties do not register the franchise agreements with the Agency. ‘The franchise agreement is considered to be valid from the day it is signed or the day determined by the parties.’64 Thus the validity of the franchise agreement does not depend on its registration with the Agency.
Russian law requires that franchise agreements are registered at the register of commercial concessions, which is maintained by the tax authorities. Failure to register it means that it is not valid as against third parties.65 In addition to information about the franchisor and franchisee, three copies of the agreement have to be filed. Termination of a franchise agreement prior to its expiration must be registered by the franchisor.66
The Indonesian franchise law takes the unusual step of requiring that it is the duty of the franchisee rather than the franchisor to register the franchise agreement and disclosure statement.67 Failure to register results in the revocation of the franchisee’s trade licence.68 Franchise licences between a foreign franchisor and a master franchisee are registered at the Ministry of Trade, while those between a master franchisee and sub-franchisees are registered at regional or municipal offices. This has led to a considerable reduction of the time for registration, namely from 150 days to around 30 days as many of the applications are now delegated to the regional offices.69
Malaysia takes a different approach and the franchisor and the franchisee are jointly required to effect the registration.70 The filing of false or inaccurate documents is an offence.71 The franchisee of a foreign franchisor must also register itself.72 Failure to register can result in penalties between 5,000 and 50,000 ringgit and up to five years’ imprisonment. In addition to this, the court can declare the franchise agreements null and void, order the franchisor to refund any payment obtained from the franchisee and prohibit the franchisor from entering into any new franchise agreement. There is provision for an annual update of the documents filed.73
In Mexico, although the disclosure document does not need to be registered with the government authorities, franchisors must record all franchise agreements at the Mexican Institute of Industrial Property on execution.74 The franchise agreement will not be registrable unless it is in writing and contains certain minimum provisions.
X COMPULSORY CONTENTS OF FRANCHISE AGREEMENTS
A number of countries insist that a franchise agreement contains certain standard clauses. There is a wide variety of approaches and no general trend or pattern can be identified other than a general desire for comprehensiveness.
In Indonesia, a franchise agreement must contain the following clauses:75
- a the name, address and domicile of the company of each party;
- b the name and position of each party authorised to sign the agreement;
- c the name and type of right over intellectual property, invention or a unique business characteristic, for example a management system, a selling or display method or a distribution method that constitutes a special characteristic that is the object of a franchise;
- d the rights and obligations of each party and the aid and facility given to a franchisee;
- e the marketing area;
- f the period of the agreement and the method of and the requirements for the extension of the agreement;
- g the method for settling a dispute;
- h mutually agreed basic provisions that may result in the termination or expiration of an agreement;
- i compensation in the event of agreement termination;
- j the procedure for the payment of compensation;
- k the use of domestically produced goods or materials produced and supplied by small-scale enterprises; and
- l nurturing guidance and training for franchises.
Malaysia takes a less detailed approach and simply prohibits discrimination between franchisees in respect of the charges offered or made for franchise fees, royalties, goods, services, equipment, rentals or advertising services if such discrimination will cause competitive harm to a franchisee who competes with a franchisee who receives the benefit of the discrimination, unless it can be objectively justified.76 It also requires that termination must be for good cause,77 be by written notice, and offer an opportunity to remedy a breach78 cited as cause for termination. A franchisor refusing to renew or extend a franchise at the end of its term must compensate the franchisee if it does not waive the post termination restrictive covenants or give the franchisee six months prior notice of the termination or non-renewal.79
Russian law stipulates the rights and obligations of both the franchisor and franchisee by providing the essential elements of the relationship. It grants a right of renewal to franchisees,80 although case law suggests that this can be circumvented in some circumstances.81 It also states that either party can terminate the franchise agreement upon six months’ notice82 and that the transfer of the franchise to another franchisee is not a breach that gives rise to a right to terminate the agreement.83
In Ukraine, the law84 imposes statutory liability of the franchisor for defective products sold by the franchisee. This is symptomatic of socialist legal traditions and is also found in Latvian and Estonian franchise law.
The Georgian Civil Code85 specifies the obligations of the parties, including confidentiality and the liability of the franchisor.
Article 16 of the Vietnamese law states that a franchisee may terminate the franchise agreement unilaterally if the franchisor is in breach of those obligations imposed upon it by Article 287 of the Commercial Law. The franchisor on the other hand is entitled to unilaterally terminate the franchise agreement in the following circumstances:
- a the franchisee no longer holds the necessary business licence or equivalent papers required by law;
- b the franchisee is involved in winding-up or bankruptcy proceedings pursuant to Vietnamese law;
- c the franchisee commits a serious legal violation that has the potential to harm the reputation of the franchise network; and
- d the franchisee fails to remedy immaterial breaches of its obligations under the franchise agreement within a reasonable time.
Under the Vietnamese Decree a franchisee may transfer its rights to another franchisee subject to:86
- a the assignee being also in the possession of a valid business licence; and
- b the franchisor giving its prior consent.
To obtain consent, the franchisee has to inform the franchisor in writing of its intention to assign its rights to a third party. Within 15 days of receiving the request, the franchisor then has to reply in writing. It may object to the transfer of rights on one of the conditions set out in Article 3 of the Decree, namely because:87
- a the assignee failed to fulfil its financial obligations under the franchise agreement;
- b the assignee has not yet fulfilled the criteria for being chosen as a franchisee by the franchisor;
- c the transfer might have an adverse effect on the existing franchise system;
- d the assignee does not agree in writing to fulfil its obligations under the franchise agreement; or
- e the franchisee has not yet fulfilled its obligations towards the franchisor.
XI DISPUTE RESOLUTION
Some jurisdictions impose certain requirements concerning dispute resolution. The New Brunswick Franchises Act is the first of the provincial statutes to provide for a comprehensive dispute resolution mechanism. The Franchises Act sets out that any party to the franchise agreement who has a dispute with another party to the agreement may deliver a notice of dispute.88 Within 15 days of delivery of the notice of dispute, the parties shall attempt to resolve it.89 If the parties fail to resolve the dispute within 30 days of the notice, the Franchises Act provides that any of the parties may deliver a notice to mediate the dispute.90 The mediation notice cannot be delivered prior to the expiration of the initial 15-day period. However, neither delivery of a notice of dispute nor a notice to mediate precludes a party from taking any other judicial measures.91 The Korean franchise law also provides for a dispute resolution mechanism and establishes a Franchise Transaction Dispute Mediation Committee.92
XII DOES REGULATION HAVE A SIGNIFICANT IMPACT ON FRANCHISING?
There is, and has always been, a good deal of debate about the need for, desirability of and impact of regulation on franchising.
The strength of franchising in the world’s most heavily regulated jurisdiction (the United States), somewhat undermines the suggestion that regulation per se has a significant and adverse impact upon franchising. Clearly, bad regulation will have a negative impact on franchising, but that does not mean that good regulation cannot have a positive impact upon franchising. Indeed the lack of good regulation can have an adverse impact on franchising. Conflict between differing regulatory regimes in a single economic region can have an even greater adverse impact upon franchising. This is what happened in the European Union. For example, the 9,971 or so franchise networks operating in the EU and the 405,000 or so outlets make a substantial contribution to the GDP of a number of Member States, with a roughly estimated total turnover of €215 billion. However, closer examination suggests that it is over-concentrated in a small number of EU Member States and a comparison with the size of franchising in the United States and Australia suggests that its potential to contribute to the single market and the growth of trade between Member States is far from being fulfilled at present, an estimated 83.5 per cent of its turnover being concentrated in only 25 per cent of the Member States.
The underachievement of franchising in the Single Market can be attributed, at least in part, to the way in which it is regulated. The regulations fail to protect and re-enforce the business reasons that attract franchisors and franchisees to franchising.
The regulatory environment in the EU comprises franchise-specific laws in six Member States. Each law is different from the others. Franchisors embarking upon a European ‘roll out’ of their concepts therefore encounter delays and costs that are a direct result of this heterogeneous approach – an artificial barrier to pan-European expansion that actively discourages franchisors to grow their businesses across the European Union.
This impact upon franchising is further exacerbated by non-franchise specific laws that can also be divided into pre-contractual, contractual and post-contractual.
The pre-contractual laws often comprise some or all of the following; a duty not to misrepresent facts, an obligation to disclose relevant information to potential franchisees, an extra-contractual obligation to disclose relevant information to potential franchisees, an extra-contractual obligation of confidentiality, an obligation to enter into the franchise agreement once negotiations have passed a certain point and a right to withdraw from the contract within a limited period. Each country takes a different approach to each of these issues resulting in the lack of any homogenous approach.
The ongoing franchisor–franchisee relationship is often regulated by antitrust, unfair competition and consumer law. A duty of good faith also impacts upon franchising in civil law jurisdictions, although not in common law jurisdictions, which take a very different approach to the concept of good faith. For example, whereas German and French law takes a loose approach based upon the Roman law concept of bona fides, English law takes a far more literal approach to contracts, using a variety of legal tools to ensure fairness on the relationship.
This exotic cocktail of laws further strengthens the technical barrier to cross-EU expansion.
When seeking to internationalise a franchise, it is important to have a full understanding of the challenges that will be presented by the legal systems of each target market. These challenges must be anticipated and taken into account not only in the drafting of the standard documentation but also in the way in which the roll-out is planned, budgeted and implemented.
Companies using franchising as a vehicle through which they will internationalise their business must expect to encounter a range of different legal challenges in each jurisdiction.
1 Mark Abell is a partner at Bird & Bird LLP.
2 Japan Fair Trade Commission Guidelines, April 2002. These provide for disclosure and offer guidance on vertical restraints.
3 The Venezuelan Pro-Competition Agency’s Guidelines for the Evaluation of Franchise Agreements, 7 January 2000. These are based upon the previous EU Franchise Block Exemption (Reg EU 4087/88).
4 Croatian Regulation on block exemption granted to certain categories of vertical agreements, Article 3(6).
5 Lena Peters of Unidroit in ‘Update on Franchising Development outside the United States’, 8 July 2009.
6 Stewart Germann, ‘New Zealand – Government says no to Franchising Regulation’, International Journal of Franchising Law, Volume 7, Issue 5, 2009.
7 See Cl. Corp. Code, Section 31005.
8 Haw. Rev. Stat. Ann., Section 482E-2; Minn. Stat. Section 80C.01.4, Wis. Stat., Section 135.05(1).
9 Cal. Corp. Code Section 31005(a)(1).
10 FTC Rule, Section 436.1(h).
11 FTC Rule, Section 437.2(1).
12 FTC Rule, Section 436.8(a).
13 16 CFR, Part 437.
14 Wisconsin Fair Dealership Law.
15 New Jersey Franchise Practices Act.
16 Wisconsin Statute Chapter 135.02(1).
17 Ziegler Co. v. Rexnord Inc  139 Wis.2d 593 N.W.2d 873.
18 These factors include: (1) the duration of the parties’ relationship; (2) the extent and nature of the parties’ obligations; (3) the percentage of time or revenue devoted to the grantor’s products or services; (4) the percentage of the grantee’s gross proceeds or profits derived from the grantor’s products or services; (5) the extent and nature of the grantee’s territory; (6) the use of the grantor’s trademarks or logos; (7) the grantee’s financial investment in the inventory, facilities, and goodwill of the alleged dealership; (8) the personnel devoted to the alleged dealership; (9) the amount of money and time spent on advertising and promotions for the supplier’s products and services; and (10) the extent of supplemental services provided by the grantee to purchasers of the grantor’s products or services.
19 Instructional Systems Inc. v. Computer Curriculum Corporation (NJ S Ct 1992) BFG 1992–1993 Para 10, 119.
20 Alberta Franchises Act, Section 1(d).
21 Trade Practices (Industry Codes-Franchising) Regulations, Section 4(2).
22 Id., Section 4(3).
23 Id., Section 5. The two main types of exempted franchise agreement are where the franchisor is resident outside Australia and only grants one franchise or master franchise to be operated in Australia. The other main exemption is ‘fractional franchises’, where the franchise agreement is for goods or services substantially the same as those previously supplied by the franchisee and the sales under the franchise are likely to provide no more than 20 per cent of the franchisee’s gross turnover).
24 The Provisions on and Procedure for the Implementation of Franchised Business Registration (Decree of the Minister of Industry and Trade No. 259/MPP/Kep/7/1997, dated 30 July 1997), Chapter 1, Article 1.1.
25 Act on Fairness in Franchise Transactions, Chapter 1, Article 2.1.
26 The Franchise Act 1998, Part 1, Section 4(d).
27 Law on Industrial Property, Title 4, Chapter VI, Article 142.
28 Judgment No. BH 2003.269.
29 Judgment No. 1 Gf 40.203/1996.4.
30 Unidroit, Model Franchise Disclosure Law, Article 2.
31 Law of 6 May 2004, No. 129 Article 1.1.
32 Ordinance Regarding the Legal Status of Franchises (Government Ordinance 52/1997) as approved and modified by Law 79/1998, Chapter 1, Article 1(a).
33 Article 62 of the Act 7/1996.
34 Lithuanian Civil Code, Article 6.766(1).
35 Id., Article 6.766(3): ‘Parties to the franchise contract may be enterprises (entrepreneurs) only.’
36 Id., Article 6.766(2).
37 Brazilian Franchise Law, Article 2.
38 Taiwan’s Standards Governing Disclosure of Information by Franchisors.
39 Id., Article 1.
40 Article 7 of the Regulation of Administration of Commercial Franchises 2007.
41 Article 6 of Decree No. 35/2006/ND-CP issued by the government to regulate franchises.
42 Id., Article 5(1).
43 Id., Article 142 of Mexico’s Industrial Property Law.
44 Article 5 of the Standards Governing Disclosure of information by Franchisors by the Fair Trade Commission.
45 Alberta Franchises Act, Section 13, the Arthur Wishart Act (Franchise Disclosure) 6(1) and (2); the Prince Edward Island Franchises Act, Chapter 36, Bill 43, Section 6(1); the New Brunswick Franchises Act, Section 6(1).
46 Law No. 8.955 of 15 December 1994, Article 4.
47 Article 28 of the Regulation on Administration of Commercial Franchises 2007.
48 Act No. 101 of 29 September 1973, as amended in April 2002, Section 12(1).
49 The Malaysian Franchise Act 1998 Part VI.
50 Law on Industrial Property, 23 November 1994, Title Seven, Chapter II, Article 213.
51 Article 24(1) of Decree No. 35-2006-ND-CP.
52 The Franchise Act 1998, Part III, Section 25.
53 Cornwallis, International Journal of Franchising Law, 2006, Volume 4, Issue 3, p. 5.
54 The Franchise Act 1998, Part II, Section 14.
55 Id., Part Im Section 4.
56 Law on Complex Business Licence (Franchising) (Law No. 330: 24 June 2002), Chapter 1, Article 1(5).
57 Id., Chapter 3, Article 13.
58 Act on Fairness in Franchise Transactions, Chapter III, Article 28.
59 Id., Article 30.
60 Id., Article 31.
61 Article 8 of the Administration Regulations and Article 5 of Administration Rules on Commercial Franchise Filing – Decree of Ministry of Commerce 2007 (No. 15).
62 Article 9(4) of the Moldovan Law on Franchising No. 1335 dated 1 January 1997 provides: ‘The franchise agreement is registered with the State Agency for the Protection of Industrial Property.’
63 Article 10(3) of the Moldovan Law on Franchising provides: ‘If the contract has ended, parties have the obligation to cease their activity and to inform the Agency within one month.’
64 Article 9(3) Moldovan Law on Franchising.
65 Russian Civil Code Part II, Chapter 54, Article 1028(2).
66 Russian Civil Code Part II, Chapter 54, Article 1037.
67 Regulation of the Minister of Trade No. 12/M-DAG/PER/3/2006 dated 29 March 2006, which revoked the Provisions on and Procedure for the Implementation of Franchised Business Registration (Decree of the Minister of Industry and Trade No. 259/MPP/Kep/7/1997, dated 30 July 1997), Chapter III, Article 11.1.
68 Id., Chapter VI, Article 22.
69 Bryan Cave International Trade, Regulatory Development in Asia, Indonesia, May 2007, www.bryancavetrade.com.
70 The Franchise Act 1998, Part II, Section 6(2) provides that failure to register amounts to an offence (unless exempted under Section 58 of the Act).
71 The Franchise Act 1998, Part II, Section 7(6).
72 Id., Part VIII, Section 55.
73 Id., Part II Section 16.
74 Regulations Under the Law on Industrial Property (23 November 1994) Title I, Chapter II, Article 5.
75 Regulation of the Minister of Trade No. 12/M-DAG/PER/3/2006 dated 29 March 2006, which revoked the Provisions on and Procedure for the Implementation of Franchised Business Registration (Decree of the Minister of Industry and Trade No. 259/MPP/Kep/7/1997, dated 30 July 1997), Chapter II, Article 7.1.
76 The Franchise Act 1998, Part III, Section 20.
77 Id., Part III, Section 31(2).
78 Id., Part IV, Section 30(1).
79 Id., Part IV, Section 32.
80 Russian Civil Code, Part II, Chapter 54, Article 1035.
81 Decision of the Federal Arbitrazh Court of East-Siberian District (FAS VSO decision) of 16 October 2003, Case No. NA19-3914/03-13-FO2-3459/03-C2.
82 Russian Civil Code Part II, Chapter 54, Article 1035.
83 Id., Article 1037.
84 Ukrainian Civil Code, Chapter 76, Articles 1115 to 1129.
85 Adopted on 26 June 1997, Book Three, Special Part, Title One, Chapter Seven (Articles 607–614).
86 Decree No. 35/2006/ND-CP, Article 15(1).
87 Id., Article 15(3).
88 Section 8(1) of the New Brunswick Franchises Act 2007 (26 June).
89 Id., Section 8(2).
90 Id., Section 8(3).
91 Id., Section 8(10).
92 Korean Act on Fairness in Franchise Transactions, Chapter IV.